Research
Discussion
Paper
Implications for the
Australian Economy of
Strong Growth in Asia
Michael Plumb, Christopher Kent and
James Bishop
RDP 2013-03
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ISSN 1320-7229 (Print)
ISSN 1448-5109 (Online)
Implications for the Australian Economy of Strong Growth
in Asia
Michael Plumb, Christopher Kent and James Bishop
Research Discussion Paper
2013-03
March 2013
Economic Group
Reserve Bank of Australia
An earlier version of this paper was prepared for the ‘Structural Change and the
Rise of Asia’ Conference, jointly hosted by the International Monetary Fund, the
Australian Treasury and the Reserve Bank of Australia, at the Hyatt, Canberra, on
19 September 2012. We would like to thank our colleagues at the Reserve Bank of
Australia for their helpful comments. The views expressed in this paper are those
of the authors and do not necessarily reflect the views of the Reserve Bank of
Australia. The authors are solely responsible for any errors.
Authors: plumbm, kentc and bishopj at domain rba.gov.au
Media Office: rbainfo@rba.gov.au
Abstract
Strong growth in Asia, particularly in China, has had a profound impact on the
Australian economy over the past decade. Most notable so far has been the boom
in the resource sector, with commodity prices and hence Australia’s terms of trade
rising to historically high levels over a number of years. This has been
accompanied by a sizeable appreciation of the exchange rate. While the terms of
trade have passed their peak, the substantial investment in productive capacity of
the resource sector in recent years is expected to provide a large boost to the
production and exports of resources in coming years.
In this paper we describe how the pattern of structural adjustment to the positive
terms of trade shock has, to date, proceeded broadly in line with that suggested by
a simple theoretical model that distinguishes between three broadly defined
sectors: the resource sector, the ‘other tradable’ sector and the non-tradable sector.
In particular, relative wages and prices adjusted in a way that facilitated the
reallocation of factors of production towards the resource sector.
While not all parts of the economy have benefited, the process of adjustment thus
far has occurred relatively smoothly in a macroeconomic sense; inflation has
remained within the target range, or not too far from it, unemployment has
remained relatively low and output has grown at close to trend rates. This stands in
stark contrast to some earlier episodes of terms of trade booms in Australia. We
argue that macroeconomic adjustment to the current terms of trade shock has been
facilitated by the appreciation of the exchange rate, the anchoring of inflation
expectations and labour market dynamics whereby wage pressures in industries or
regions experiencing strong conditions associated with the boom in resource
investment have not spilled over to parts of the economy experiencing weaker
conditions.
JEL Classification Numbers: E02, E20, N15, N17, Q33, Q43
Keywords: Australian macroeconomy, economic performance, terms of trade,
resource boom, industry analysis
i
Table of Contents
1. Introduction
1 2. Adjustment to a Commodity Price Boom: A Theoretical Perspective
6 2.1 The ‘Model’
6 2.2 The Adjustment to the Shock
8 The Resource Boom and Structural Change
13 3.1 Phase I: Rise in the Terms of Trade
17 3.2 Phase II: Surge in Resource Investment
3.2.1 Investment
3.2.2 Impact of the surge in resource investment on the
output of other sectors
3.2.3 Employment
3.2.4 Wages
3.2.5 Consumer prices
3.2.6 Interest rates
20 20 3.3 Phase III: Mining Production and Exports
3.3.1 Mining production and exports
3.3.2 Non-resource exports
33 33 35 3.4 Beyond the Resource Investment Boom
37 3. 4. 21 24 27 30 32 Conclusion
39 Appendix A: Data
42 References
43 ii
Implications for the Australian Economy of Strong Growth in Asia
Michael Plumb, Christopher Kent and James Bishop
1.
Introduction
Strong economic growth in the Asian region, particularly in China, over the past
decade or more has had important macroeconomic and structural effects on the
Australian economy. Most obvious has been the rise in the terms of trade to
historically high levels (Figure 1), an appreciation of the exchange rate, a surge in
resource investment, and a reallocation of factors of production, with employment
growing strongly in resource and resource-related activities and declining in a
number of non-resource industries.
Growth in Asia is providing many benefits for the Australian economy. The
commodity-intensive nature of this growth has pushed bulk commodity prices to a
high level, which is supporting significant investment in the productive capacity of
the Australian resource sector and is expected to continue to support the production
and export of resources, as well as employment, incomes, tax revenues and wealth.
The appreciation of the exchange rate has lowered the cost of many imported
goods for Australian consumers. While not all parts of the economy have benefited
from this change in relative prices, for the economy as a whole the process of
adjustment has proceeded much more smoothly than has been the case in previous
terms of trade booms; over the past eight years, inflation has remained within the
target range, or not too far from it, and growth has generally not been too far from
trend (Figure 2). This is perhaps all the more notable given the difficult
circumstances internationally over recent years, with incomes in Australia growing
faster than in most other advanced economies and the unemployment rate
remaining relatively low. In part, this reflected the relative strength of the Chinese
economy through 2009 and 2010 that benefited Asia and pushed Australia’s terms
of trade to new highs after they dipped during the height of the global financial
crisis.
2
Figure 1: Terms of Trade and the Exchange Rate
2003/04 = 100, financial year
Index
Index
(a)
Terms of trade
160
160
130
130
100
100
70
70
Five-year-centred moving average
Index
Index
TWI exchange rate
160
160
Nominal
130
130
100
100
(b)
Real
70
70
40
1875
Notes:
1895
1915
1935
1955
1975
1995
40
2015
(a) Includes the February 2013 Statement on Monetary Policy (SMP) forecasts for 2012/13, 2013/14 and
2014/15, see RBA (2013)
(b) Calendar year data prior to 1970
Sources: ABS; Gillitzer and Kearns (2005); McKenzie (1986); RBA; authors’ calculations
3
Figure 2: Australia’s Relative Economic Performance
Quarterly
Index
GDP(a)
GDP per capita(a)
130
Index
130
Australia
115
115
100
100
(b)
Other advanced economies
%
(range)
(c)
Unemployment rate
CPI inflation
8
8
4
4
0
0
-4
2007
Notes:
%
2012
2007
-4
2012
(a) March quarter 2003 = 100
(b) Canada, euro area, Japan, NZ, UK and US
(c) Year-ended; excludes Japan
Sources: ABS; Eurostat; Statistics New Zealand; Thomson Reuters; US Census Bureau
The relatively smooth adjustment of the economy overall, at least to date, has
certainly not been the norm in previous booms. A key contributor to the good
performance of the macroeconomy through the current boom has been the
flexibility of the exchange rate. The high nominal exchange rate has acted as a
timely mechanism for facilitating the reallocation of labour and capital across
industries. Of course, this process is not a painless one. It entails significant
pressures on many trade-exposed industries that have not benefited from higher
product prices but have faced higher wages (at least in foreign currency terms) and
a softening in demand.
As well as promoting the reallocation of labour and capital across the economy, the
high exchange rate has been one of the means by which Australian consumers have
been able to benefit from high commodity prices, by directly increasing their
purchasing power over imports. Indeed, the purchasing power of the average wage
has risen in all major industries since the terms of trade began to rise in 2003/04,
4
despite upward pressure on the prices of non-tradable goods and services during
the boom. 1 For some industries, such as mining, construction and professional
services, the real (consumer) wage has grown quite strongly, while growth in real
wages has been more subdued, yet still positive, in rental, hiring & real estate,
retail and manufacturing.
Another feature of this terms of trade boom is the greater extent of foreign
ownership of the resource sector, with some estimates suggesting that foreign
ownership is around four-fifths (Connolly and Orsmond 2011). In addition, the
imported content of the current boom in resource investment has been high. Both
of these factors mean that the expansionary effect of the boom is less than is
implied by the extent of growth in investment and profits in the resource sector.
The adjustment process through the current episode has also been helped by
inflation expectations remaining well anchored and greater flexibility in the labour
market relative to earlier terms of trade booms. The combination of the high
exchange rate, a record of low and stable inflation and a relatively flexible labour
market means that while demand for labour, and the growth of wages, has
increased in the resource sector, this has not led to a significant increase in wages
in Australian dollar terms across the economy as a whole. This was not the case in
earlier terms of trade booms. 2
The smooth adjustment to date suggests that the economy is reasonably well
placed to deal with further adjustments that lie ahead. One aspect of this is that the
resource boom is expected to turn from one of strong growth in resource
investment to one of strong growth in the production and exports of resources.
Given that many resource projects employ more labour during the construction and
investment phase than during operations, this means that the demand for labour in
the resource sector is likely to ease after the peak in investment. Another feature of
the adjustment is the decline in the terms of trade from its peak. Indeed, this is
already under way, with commodity prices having peaked in late 2011 and forecast
to decline further over time as the global supply of commodities gradually
increases relative to demand. As with the expansionary phase of the boom, a
1 The purchasing power of the average wage is calculated by deflating average weekly earnings
in each industry by the household final consumption deflator.
2 See, for example, Battellino (2010).
5
flexible exchange rate would also be expected to help the economy adjust to both
anticipated and unanticipated developments, such as a path of the terms of trade
that varies substantially from that which is expected. Similarly, the path of
resource investment, in particular the timing and magnitude of the peak in
investment, and the demand for, and supply of, labour in the resource sector are
also subject to a degree of uncertainty.
In terms of the path of the terms of trade, an important unknown is the extent to
which the growth in the demand for commodities, which has been very strong over
recent years, might ease over the longer term as the emerging economies in Asia
mature. For example, the rate of urbanisation in Asia, which has driven much of
the demand for iron ore and coal, is expected to eventually slow and then stabilise 3
(although demand for non-resource commodities such as food and fibres is likely
to increase as populations and incomes grow). Also, the typical pattern of
economic development suggests that activity in emerging Asia is likely to become
less focused on the production and consumption of goods over time and relatively
more focused on the production and consumption of services. While such a
transformation might appear to be disadvantageous for countries like Australia that
have hitherto focused on supplying these economies with commodities, it may be
that Australia is able to benefit from such a shift. Indeed, some Australian service
industries, such as education and tourism, have already experienced an increase in
demand from Asia, notwithstanding the high level of the exchange rate. Moreover,
incomes still have a long way to grow in much of the Asian region to reach levels
recorded in the advanced economies. And rising incomes in this large part of the
global economy will be relatively advantageous for Australia, in part because the
distance from Australia to the region is much less than the distance from Australia
to most other advanced economies, but also because of its well-developed and
relatively open services sector.
In the remainder of this paper we examine the implications for the Australian
economy of strong growth in Asia, particularly in the context of the large increase
in the terms of trade since the mid 2000s. Specifically, we examine developments
in three broadly defined sectors: the resource sector, the ‘other tradable’ sector and
the non-tradable sector. Section 2 presents a theoretical framework that describes
how a small open economy might be expected to adjust to a boom in commodity
3 See, for example, Berkelmans and Wang (2012).
6
prices. Within the context of this theory, Section 3 then discusses sectoral
developments in the Australian economy through the three (overlapping) phases of
the resource boom: the increase in the terms of trade; the surge in resource
investment; and the subsequent growth in the production and exports of resources.
Section 4 concludes.
2.
Adjustment to a Commodity Price Boom: A Theoretical
Perspective
2.1
The ‘Model’
Before turning to the question of how the Australian economy has adjusted to the
increase in commodity prices, we first describe how a small open economy such as
Australia’s might adjust in theory to such a boom, drawing on earlier work by
Gregory (1976), Corden and Neary (1982) and Corden (1982, 1984). A key part of
the adjustment process is the appreciation of the real exchange rate. Much of that
can occur via the nominal exchange rate in the case of an inflation-targeting regime
with a flexible exchange rate such as that which exists in Australia. The real
exchange rate must still appreciate in the case of a fixed nominal exchange rate
regime, but more of this occurs through inflation of wages and prices, as was the
case in Australia during the Korean War wool boom of the 1950s. 4 By helping to
insulate the domestic economy from these inflationary pressures, the flexible
exchange rate is an integral part of a smooth transition, and one that provides
important benefits to the economy given that, in reality, the future path of the terms
of trade is not certain.
To understand the elements of the adjustment process, we briefly describe a small
open economy model with three sectors: the resource sector, the ‘other tradable’
sector and the non-tradable sector; two factors of production – labour and capital,
and (mineral and energy) resource endowments. Most of the resource commodities
produced are assumed to be exported. Resource endowments can be thought of as
being in fixed supply, but of varying quality (that is, some bodies of ore or deposits
of oil and gas are more costly to extract than others). Extraction requires building
capital ‘infrastructure’, removing any overburden, digging wells, and building
4 For a discussion of the Korean War wool boom episode, see Appendix A of Plumb, Kent and
Bishop (2012).
7
extraction, processing and transport facilities. All of this takes some years to put in
place but then lasts for many years.
In the case of Australia’s recent experience, the shock to commodity prices that
underpinned the increase in the terms of trade is best thought of as being quite
persistent. Even though the exact extent of the boom has been, and remains,
uncertain, the key point is that commodity prices rise to a high level for quite some
time. They are then expected to decline as more supply is brought forth, at home
and elsewhere in the world.
A persistent increase in commodity prices leads to a rise in investment in the
resource sector. This takes place over the course of a number of years because it is
quite costly, or even impossible, to adjust the capital stock rapidly.
The process of adjustment to the boom in the terms of trade can usefully be
characterised as occurring in three overlapping phases. 5 First, commodity prices,
and hence the terms of trade, increase significantly. Second, the investment phase
entails a build-up in the capital stock in the resource sector over a number of years.
This phase is relatively intensive in the use of labour when compared to the third,
longer-lived operational phase when production and exports of resources increase
significantly. The terms of trade is expected to eventually decline in response to
the extra capacity coming on line around the world.
Exactly how the economy responds to the increase in the terms of trade will
depend on the response of the exchange rate, interest rates, wages and prices. This
will depend in part on the degree of substitutability of labour across the different
sectors, as well as the substitutability between tradables and non-tradables in
consumption. In what follows, we assume that nominal wages are quite sticky
downwards (that is, it takes relatively high levels of unemployment to bring down
nominal wages), and that there is some substitutability across sectors, but it may
not be not perfect, in which case relative wages across the different sectors might
change over time. Similarly, we assume that tradable and non-tradable goods and
services are substitutable, but not perfectly so. Finally, we assume that prices
5 To our knowledge, Gregory (2011b) was the first to cast the current resources boom as one
that takes place in three distinct phases. See also Sheehan and Gregory (2012), which is
forthcoming in the Australian Economic Review.
8
adjust gradually, at least in comparison to the nominal exchange rate in the case
where the latter is flexible.
There is a long history of research on how a small open economy adjusts to a boom
in its resource sector. The canonical model, which divides the economy into a
tradable and non-tradable goods sector, was first described by the Australian
economists Salter (1959) and Swan (1960). This model was later extended to
include three sectors – a booming tradable sector, a lagging tradable sector and a
non-tradable sector – in the so-called ‘Dutch Disease models’ (Gregory 1976;
Corden and Neary 1982; Corden 1982, 1984). The development of these models
was motivated by the need to understand better the linkages between structural
changes that were taking place in Australia and a number of other countries in the
1960s and 1970s and the development of the resource export sector. 6 A number of
commentators have drawn on the predictions of these models to explain the
adjustments the economy is currently going through (Gruen 2006, 2011;
Henry 2006, 2008; Banks 2011; Connolly and Orsmond 2011; Corden 2012). The
contribution of the present study is not to ‘reinvent the wheel’, but rather to outline
the various adjustments that are taking place in Australia, both from a theoretical
and empirical standpoint, and to consider the likely transition path of the economy
once the ‘investment phase’ of the boom peaks and the economy moves into the
‘production phase’ of the boom.
2.2
The Adjustment to the Shock
To think about how the economy responds to the positive terms of trade shock in
the context of the theoretical model, it is helpful to start by considering the forces
acting on the various ‘prices’ in the economy (that is, consumer prices, wages,
interest rates and the exchange rate) at the onset of the shock. This provides a
guide as to how these variables will need to adjust (relative to their baseline paths)
to bring about equilibrium.
6 As Gregory (2011a) has noted, another purpose of these models was to increase
understanding of the potential effects of two policy instruments that had not generally been
used in Australia – a large across-the-board tariff cut and changes in the nominal exchange
rate.
9
A positive shock to the terms of trade, resulting from a rise in commodity prices,
increases income accruing to the resource sector and increases that sector’s
demand for productive inputs. This exerts a degree of inflationary pressure,
implying that:
 At initial wages, there will be excess demand for labour emanating from the
resource sector. Assuming that the economy begins this adjustment at close to
full employment, this will put upward pressure on wages as the resource sector
seeks to draw in labour from the ‘other tradable’ and non-tradable sectors.
 Similarly, at the initial exchange rate, there will be an excess demand for
Australian dollars, reflecting an increase in the overall demand for Australian
resources and assets that will begin to generate a higher return. The pressure for
the appreciation can also be viewed as a forward-looking response to the
demand for offshore funds that will be needed to help finance investment in the
resource sector. To the extent that the exchange rate appreciates, demand for the
exports of the ‘other tradable’ sector will decline.
 At initial prices of goods and services, extra income associated with the terms of
trade shock implies an excess demand for the output of the non-tradable sector,
which will tend to put upward pressure on prices and wages in that sector. To
the extent that the exchange rate appreciates, downward pressure on the prices
of imported goods could induce substitution away from non-tradable goods and
services, or free up income to spend on non-tradable goods and services. Given
these opposing forces, the net outcome for demand in the non-tradable sector is
not clear a priori. Upward pressure on prices will also be reduced to the extent
that profits associated with the terms of trade shock accrue to foreigners and
investment is sourced from imports.
 Upward pressure on wages and prices associated with demand from the resource
sector, and any excess demand in the non-tradable sector, might require an
increase in interest rates in order to contain inflation; this will depend in part on
the extent of the exchange rate appreciation. Also, the need for interest rates to
rise will be lessened to the extent that inflation expectations remain well
anchored and wage pressures in stronger parts of the economy do not spill over
to other parts.
10
Pulling all of this together implies the following. The positive terms of trade shock
will cause the nominal exchange rate to appreciate. By itself this pushes up
Australian wages in foreign currency terms and thereby frees up labour from the
‘other tradable’ sector – that is, the rise in wages in foreign currency terms
represents a loss of competitiveness for this sector. What happens to wages in
Australian dollar terms will depend on the extent of the nominal exchange rate
appreciation, whether demand for non-tradable goods and services rises or falls,
and the substitutability of labour across sectors. It is likely that wages in Australian
dollar terms will rise in the resource and non-tradable sectors relative to the ‘other
tradable’ sector. To the extent that wages in Australian dollar terms rise overall
(again, relative to the baseline), the real exchange rate appreciates further than is
implied by the nominal exchange rate appreciation alone. In any case, there is a
clear signal for labour to leave the ‘other tradable’ sector and move towards the
resource sector (and possibly the non-tradable sector if its demand also rises).
In theory at least, at the time of the terms of trade shock, the nominal exchange rate
will jump higher and interest rates will rise. The interest rate differential (vis-à-vis
the rest of the world) means that the exchange rate can then be expected to
depreciate in a smooth fashion along the path of adjustment. This is because
arbitrage in the foreign exchange market requires the expected return on holding
Australian dollar assets to be equal to the expected return on foreign currency
assets. 7 The higher interest rate during the course of adjustment will also
discourage some investment outside of the resource sector.
What can we say about prices? Domestic inflationary pressures, associated with
higher wages and incomes, will lead to higher inflation for non-tradable goods and
services but, at the same time, the gradual pass-through of the initial exchange rate
appreciation will lead to lower inflation for tradable goods and services (whose
prices in foreign currency terms depend to an extent on global considerations). In
this way, the appreciation of the exchange rate helps to offset the inflationary
impulse from the terms of trade shock, and assists in maintaining inflation in line
with the inflation target.
7 The theory of uncovered interest parity (UIP), which connects expected changes in the
exchange rate to interest differentials, is central to many international macroeconomic models.
Yet empirically, UIP is consistently found not to hold (for a survey, see Engel (1996)).
11
These changes will unwind to some extent as the adjustment process runs its
course. As the capital stock in the resource sector reaches its new equilibrium
level, demand for labour in the resource sector overall will decline as the relatively
labour-intensive investment there declines. Even so, labour demand in the resource
sector will still remain somewhat higher than it was prior to the terms of trade
shock given the operational needs associated with producing more output. The net
reduction in labour demand in the resource sector when moving from the
investment to the operational phase of the boom implies that labour needs to be
reabsorbed into the non-resource sector. This will tend to put some downward
pressure on wage growth, although this effect will be mitigated somewhat to the
extent that the demand for non-tradable goods has increased since the onset of the
terms of trade shock (that is, if the income effect has outweighed the substitution
effect). The reduction in wage growth that does occur, when coupled with some
improvement in the competitiveness of the ‘other tradable’ sector due to the
exchange rate depreciation (that begins, in theory, immediately after the
unexpected boom to the terms of trade and initial appreciation), will help the nonresource sector to absorb the labour being shed by companies that undertook the
resource investment.
The price changes seen during the investment phase of the boom will be at least
partly reversed during the operational phase of the boom. In particular, the gradual
depreciation of the exchange rate (following the initial appreciation) will put
upward pressure on tradable inflation over time, while a reduction in wage growth
will put downward pressure on non-tradable inflation. These opposing effects may
result in little net change to overall inflation. In this case, inflation can again
remain in line with the target and the interest rate can return to its neutral level. In
line with this discussion, Figure 3 provides a stylised illustration of how key
variables might respond to a persistent positive shock to global commodity prices.
In reality, there are a number of reasons why an economy might not adjust in
accordance with the theory outlined above; for example, households, firms and
authorities do not have perfect knowledge of the timing and magnitude of the terms
of trade boom at the outset, and it takes time for firms to adjust to changing
circumstances. There are also many forces affecting the economy at a given point
in time, making it difficult to isolate the impact of a single shock. Nonetheless, the
12
theory provides a useful heuristic framework for analysing the response of the
Australian economy to the resource boom.
Figure 3: Stylised Dynamics of Key Prices and Quantities Following a
Persistent Positive Shock to Global Commodity Prices
Resource investment
Nominal exchange rate
Resource exports
Real exchange rate
Resource employment
Interest rate
Resource capital stock
Deviation from baseline
Terms of trade
(a)
Tradable inflation
l
t=0
Note:
(a) Refers to consumer prices
(a)
Non-tradable inflation
l
t=0
Time after initial shock (at t = 0)
13
3.
The Resource Boom and Structural Change
Developments in the Australian economy since the onset of the current resource
boom have been broadly consistent with the stylised framework outlined in
Section 2. In response to the large increase in commodity prices and the terms of
trade, investment and employment in the resource sector grew strongly, placing
upward pressure on prices and wages. This was offset to some extent by an
appreciation of the exchange rate, which led to a loss of competitiveness and
downward pressure on prices in other industries exposed to foreign trade.
This section examines these developments in more detail, by considering the three
(overlapping) phases of the resource boom:
 Phase I: increase in the terms of trade.
 Phase II: surge in resource investment.
 Phase III: mining production and export phase.
We look at how key variables in the resource, ‘other tradable’ and non-tradable
sectors have evolved over recent years, while also noting some important ways in
which developments in the Australian economy are not well represented by the
theoretical framework presented in Section 2.
Our measure of the ‘resource sector’ is based on the measure of the ‘resource
economy’ outlined in Rayner and Bishop (2013).8 In this measure, the resource
sector is defined broadly to include both resource extraction and resource-related
activity:
 Resource extraction. This includes mineral and gas extraction, and also
resource-specific manufacturing (such as the production of metals and refined
petroleum). This is very close to the ABS’ definition of the mining industry, the
only difference being that it also includes resource-specific manufacturing.
8 The methodology detailed in Rayner and Bishop builds on that in Kouparitsas (2011), which
was implemented in Gruen (2011).
14
 Resource-related activity. This includes the provision of intermediate inputs that
are used in the current extraction of resources as well as investment that
supports future extraction of resources. In other words, it captures activities that
are directly connected to resource extraction, such as constructing mines and
associated infrastructure, and transporting inputs to, and taking extracted
resources away from, mines. It also captures some activities less obviously
connected to resource extraction, such as engineering and other professional
services (legal and accounting work, for example).
The remainder of the economy – the non-resource sector – can usefully be divided
into two parts: 9
 ‘Other tradable’ sector: comprises industries (or parts of industries) that are
significantly exposed to international trade, but not directly related to the
resource sector. This includes agriculture, manufacturing, transport, wholesale
trade and accommodation & food services. For each of these industries, exports
or competing imports are significant as a share of gross output.
 Non-tradable sector: comprises industries that typically do not have a significant
exposure to international trade, and for which production is not directly linked to
the resource sector.
9 Rayner and Bishop (2013) provide estimates of the gross value added (GVA) and
employment in each industry that is directly connected to the resource sector. For this reason,
in the ‘other tradable’ and non-tradable sectors used in the current paper, the parts of
industries that are directly related to the resource sector are removed. This means that part of
manufacturing GVA and employment is classified to the resource sector and part to the ‘other
tradable’ sector, for example. The approach is different for sectoral estimates of investment
and wages, which are based on the simple industry classification in Table A1.
15
The literature proposes several methods for creating this division (of the nonresource economy) in practice; see Dwyer and Groeger (1994) for a review. Our
allocation is consistent with a ‘threshold’ approach, in which industries are
allocated to the ‘other tradable’ sector if either their exports or competing imports
are greater than a certain share of their gross output (generally 10 per cent; see
Table A1). 10
The key prices and quantities of interest are shown in Table 1, which compares the
inflation-targeting period up to 2002/03 with the period of the rapidly rising terms
of trade thereafter.
10 More precisely, an industry is classified to the ‘other tradable’ sector if more than 10 per cent
of its total production was exported, or if competing imports accounted for more than
10 per cent of the industry’s total supply, in 2008/09. The ‘other tradable’ sector in this article
differs slightly from that in the previous version of this paper (Plumb et al 2012). In the
current paper, the wholesale trade industry is also included in the ‘other tradable’ sector,
reflecting updated information from the 2008/09 input-output tables.
16
Table 1: Key Prices And Quantities
Annual average growth, per cent
Terms of trade
Nominal TWI exchange rate
Real TWI exchange rate
Borrowing rates (housing)(a)
Borrowing rates (business)(a)
Consumer price index(b)
Tradable
Non-tradable
Wage price index(c)
Resource/mining
Other tradable
Non-tradable
Real investment
Resource
Other tradable
Non-tradable
Employment
Resource
Other tradable
Non-tradable
Real output (GVA)
Resource
Other tradable
Non-tradable
Real exports
Resource
Non-resource
Notes:
Pre terms of trade boom
1992/93–2002/03
Terms of trade boom
2003/04–2011/12
½
–¾
–1
7¾
8
2½
2
2¾
3¼
3
3
3¼
6¼
5¼
5½
7
2
½
0
2¾
3¾
3¾
3
4½
6
5½
6
7
4
5¼
7
7¼
2¾
1½
4
3¾
4¾
3½
4
6½
22¼
4¼
4¾
2¼
11¼
–1
2¼
3
6½
¾
3
3
3½
2
(a) Average of nominal interest rates on outstanding loans (fixed and variable); pre terms of trade boom
average is 1993/94–2002/03
(b) Consumer price data exclude interest charges prior to September quarter 1998 and deposit & loan
facilities to June quarter 2011, and are adjusted for the tax changes of 1999–2000
(c) Pre terms of trade boom average is 1997/98–2002/03
Sources: ABS; APRA; Perpetual; Rayner and Bishop (2013); RBA; authors’ calculations
17
3.1
Phase I: Rise in the Terms of Trade
Australia experienced a large increase in its terms of trade, rising by 82 per cent
since 2003/04 to reach their highest level on record in September 2011; they have
subsequently declined by around 17 per cent.
This run-up in the terms of trade has provided a significant boost to the real
purchasing power of domestic production, given that a larger volume of imports
can be purchased with a given volume of exports. For example, Stevens (2010)
noted that, prior to the terms of trade boom, a ship load of iron ore was worth about
2 200 flat screen television sets. In 2010, it was worth about 22 000 flat screen
television sets. This is akin to saying that Australians have received a transfer of
income from the rest of the world. The increase in purchasing power flowing from
a rise in the terms of trade can be estimated by comparing real GDP to real gross
domestic income (GDI). Since the mid 2000s, growth in real GDI has exceeded
that in real GDP by around 10 percentage points. However, Australians did not
receive all of this transfer of income from the rest of the world, given that part of
the resource sector is foreign-owned.
The distribution of these real income gains across the economy depends, crucially,
on how much the exchange rate appreciates in response to the increase in world
commodity prices (RBA 2005). An appreciation of the exchange rate means that:
the increase in the domestic currency price of commodity exports will be less than
the increase in world commodity prices; the income of the ‘other tradable’ sector
will fall; and real income gains flow to the broader economy via the associated
decline in the price of imports.
18
The exchange rate has played a particularly important role in smoothing the effects
of terms of trade shocks in Australia during periods of rising commodity prices. 11
Since the terms of trade started to rise in 2003/04, the nominal exchange rate has
appreciated by around 25 per cent in trade-weighted terms. Thus, as described in
Blundell-Wignall and Gregory (1990), most of the real exchange rate appreciation
necessary to maintain internal balance following the terms of trade shock has been
achieved by an appreciation of the nominal exchange rate. This has not been the
case in much earlier terms of trade booms in Australia, during which the exchange
rate was either fixed or heavily managed, when much of the adjustment to the real
exchange rate was achieved via higher inflation.
However, the nature of the increase in commodity prices and the terms of trade,
and the exchange rate appreciation, demonstrates a clear distinction between the
theory presented in Section 2 and the reality of the current boom. In particular, the
large rise in the terms of trade occurred over a number of years, rather than a
one-off jump, and the extent of the rise was largely unexpected. This reflects the
fact that the pace of development in emerging Asia consistently exceeded
expectations (Figure 4). As a result, analysts (including official forecasters)
under-predicted the extent of the increase in commodity prices, and therefore the
terms of trade, and so the associated exchange rate appreciation also occurred over
a number of years.
11 See Blundell-Wignall and Gregory (1990), Gruen and Wilkinson (1994) and Debelle and
Plumb (2006) for a discussion of episodes following the floating of the Australian dollar in
1983.
19
Figure 4: Chinese GDP Growth and the Terms of Trade
%
%
(a)
China – GDP growth
13
13
10
10
7
7
Consensus forecasts
(b)
Index
Index
(c)
Terms of trade
2003/04 average = 100
180
180
140
140
RBA forecasts
100
100
60
60
1999
Notes:
2003
2007
2011
2015
(a) Annual average
(b) As at January of first forecast year
(c) The latest forecast is at the February 2013 SMP; the latest reading is December quarter 2012, which
was published after the February SMP
Sources: ABS; CEIC; Consensus Economics; RBA
20
3.2
Phase II: Surge in Resource Investment
3.2.1 Investment
The resource sector globally has responded to the large rise in commodity prices
by expanding its productive capacity. This has occurred gradually over a number
of years, reflecting the unforeseen magnitude of the increase in commodity prices
and the time required to plan for, approve and then complete large investment
projects. In Australia, the growth in investment in the extraction of iron ore, coal
and liquefied natural gas (LNG) has been exceptionally strong over recent years,
accounting for most of the strong growth of resource sector investment (Figure 5).
Indeed, the net capital stock of the resource sector is estimated to have risen by
more than 150 per cent in real terms since 2003/04, and is expected to continue to
grow rapidly over the next few years, particularly in the LNG sector. At the time of
the Bank’s February 2013 Statement on Monetary Policy (SMP), the central
forecasts for growth embodied the expectation that investment in the resource
sector would peak at a little over 8 per cent of GDP in 2012/13, compared to its
average of 2 per cent of GDP over the past half century.
The effect of this surge in investment on GDP is lessened by the fact that a
significant share of the investment is imported. In aggregate, it appears that around
half of the value of these resource investment projects is imported, although this
varies somewhat depending on the nature of the project. LNG projects, for
example, typically involve higher shares of imported capital inputs. (The estimates
of resource sector GVA presented in Section 3.2.2 of this paper have adjusted the
value of mining investment for its estimated import content.)
21
Figure 5: Real Investment Growth by Sector
Three-year-centred moving average, financial year
%
%
Resource
30
30
20
20
Non-tradable
10
10
0
0
Other
tradable
-10
-10
-20
1971
1981
1991
2001
-20
2011
Sources: ABS; authors’ calculations
In contrast, investment growth in the ‘other tradable’ and non-tradable sectors has
slowed over recent years (Table 1 and Figure 5). Growth in ‘other tradable’
productive capacity has been particularly soft, which may reflect, in part, the high
level of the exchange rate, whereas the slowing in growth in non-tradable capacity
may reflect other forces acting on demand and confidence in this sector (see
below).
3.2.2 Impact of the surge in resource investment on the output of other sectors
As the surge in resource investment gathered pace, the output of the broader
resource sector, as measured by its gross value added (GVA), increased strongly
(Figures 6 and 7). This is particularly notable for the resource-related construction
and business services industries, which have supplied a large quantity of inputs
required for resource extraction and investment.
22
Figure 6: Real GVA Growth by Sector
Three-year-centred moving average, financial year
%
%
Resource
8
8
6
6
Non-tradable
4
4
2
2
Other tradable
0
0
-2
-2
1995
1999
2003
2007
2011
Sources: ABS; Rayner and Bishop (2013); authors’ calculations
To sustain the growth in the resource sector, factors of production were drawn
from the ‘other tradable’ and non-tradable sectors, and GVA growth in those
sectors slowed. In the case of the ‘other tradable’ sector, total GVA even declined
in some years, with particular weakness in parts of manufacturing that do not
supply many inputs to the resource sector, such as textiles, clothing & footwear
and wood & paper manufacturing. Growth in GVA of the non-tradable sector has
also slowed, but by less than the ‘other tradable’ sector. This suggests that the
‘income effects’ generated by the higher terms of trade (which tend to boost
demand for non-tradable goods and services) outweighed the ‘substitution effects’
created by the fall in the price of tradable goods and services relative to the price of
non-tradables (which tend to diminish demand for non-tradables relative to
tradables).
23
Figure 7: GVA by Sector
Share of nominal GVA, financial year
%
%
Other tradable
20
60
Non-tradable
10
50
Resource
0
1994
Note:
2003
2012
1994
2003
40
2012
The sum of the shares does not equal 100 per cent due to the exclusion of ownership of dwellings
Sources: ABS; Rayner and Bishop (2013); authors’ calculations
It should also be noted that there have been factors other than the large increase in
commodity prices and the high exchange rate that have had an effect on economic
activity in Australia. For example, the global financial crisis caused significant
disruption to financial markets and economic activity, albeit to a much lesser
extent in Australia than in the north Atlantic economies. There was also an
increase in the rate of household saving from the early 2000s, a slowing in credit
growth and a transition to more stable levels of indebtedness and housing prices
(relative to incomes). In addition to its direct impact on financial sector output, this
has contributed to weakness in non-resource construction and turnover in the
established housing market, as well as slower growth of retail spending than the
strong growth experienced in the years prior to the global financial crisis
(Lowe 2012b; Stevens 2012). Furthermore, there was a relatively broad-based
slowing in Australia’s productivity growth from the early 2000s; some but
certainly not all of this can be explained by developments in the resource sector
(D’Arcy and Gustafsson 2012).
24
3.2.3 Employment
Following the onset of the terms of trade boom, aggregate employment grew at an
above-trend pace. The composition of employment growth also changed
significantly (Figures 8 and 9). The share of total employment accounted for by the
resource sector (including both resource extraction and resource-related activity)
doubled since the mid 2000s, to be around 9¾ per cent in 2011/12. 12 Around twofifths of this growth reflected the expansion in resource investment, which
increased demand for labour in resource-related construction and other industries
that provide inputs to these investment projects (such as some types of machinery
manufacturing and engineering services). The share of workers employed in
resource extraction accounted for only about one-quarter of the overall increase in
the resource sector’s share of employment since the mid 2000s, while the
remainder has been due to an increase in employment in industries that service the
operations of mines (such as transport of output from mine sites to ports, business
services and power generation).
Once the peak in resource investment has passed and the extraction of resources
increases, the share of labour employed in the more labour-intensive resourcerelated sector is likely to decline and the share employed in the less labourintensive resource extraction sector is likely to rise. The expected net effect though
is a decline in labour demand in the resource sector.
12 These estimates for employment assume that the productivity of a worker who works in a
particular industry will be the same if they supply their labour to the resource or non-resource
sectors of the economy (see Rayner and Bishop (2013)).
25
Figure 8: Employment Growth by Sector
Three-year-centred moving average, financial year
%
%
15
15
Resource
10
10
5
5
Non-tradable
0
0
Other tradable
-5
-5
1995
1999
2003
2007
2011
Sources: ABS; Rayner and Bishop (2013); authors’ calculations
Figure 9: Employment by Sector
Share of total employment, financial year
%
%
Other tradable
(LHS)
20
80
Non-tradable
(RHS)
10
70
Resource
(LHS)
0
60
1992
1996
2000
Sources: ABS; Rayner and Bishop (2013); authors’ calculations
2004
2008
2012
26
Employment outcomes in the ‘other tradable’ and non-tradable sectors are
consistent with labour moving to the resource sector in response to the higher
relative wages on offer (see below), but could also reflect other factors. In contrast
to the strong employment growth in the resource sector, employment growth has
slowed in the non-tradable sector (particularly in retail and the parts of
construction not exposed to the resource sector). The share of labour employed in
the non-tradable sector has plateaued since around the mid 2000s, and is in line
with the relatively stable share of non-tradable goods and services in production.
However, as noted above, other developments largely unrelated to the high level of
the terms of trade and the exchange rate are likely to have played a role in the
stabilisation of the share of employment and output in the non-tradable sector.
Most obvious is the weakness in the housing market; as a share of nominal GDP,
dwelling investment peaked in 2003 at about 6½ per cent and has trended down to
be around 4¾ per cent in 2012.
Employment growth has been even weaker in the ‘other tradable’ sector, and its
share of employment has fallen since the mid 2000s (particularly in
manufacturing). It is worth noting, however, that the recent decline in the ‘other
tradable’ sector’s share of total employment is a continuation of a longer-run
structural shift since the 1960s. As real incomes have risen, consumer demand has
shifted increasingly toward services, and this, combined with deregulation and
privatisation of a range of services industries and the reduction in the level of trade
protection provided to goods-producing industries, has seen the tradable sector’s
share of employment decline, and the non-tradable (service) sector’s share
increase. 13
13 This structural trend is particularly evident for manufacturing, whose share of employment
fell from one-quarter in the 1960s to less than one-tenth in 2012.
27
3.2.4 Wages
The pace of aggregate wage growth picked up between 2003 and 2008 (Figure 10).
This reflected considerable pressures on capacity in the economy prior to the
global financial crisis, with the unemployment rate declining to its lowest level in
more than three decades. When the slowdown associated with the global financial
crisis occurred, these pressures on capacity eased and there was a significant
moderation in wage growth. Aggregate wage growth subsequently picked up from
these earlier low levels as activity recovered.
Figure 10: Wage Price Index Growth
Private sector, year-ended
%
%
4.5
4.5
4.0
4.0
3.5
3.5
Terms of trade
boom average
3.0
3.0
Pre-boom
average
2.5
2.5
2.0
2.0
2000
2003
2006
2009
2012
Notes:
Pre-boom average is 1997:Q3–2003:Q2; terms of trade boom average is 2003:Q3–2012:Q4
Source:
ABS
Wages have risen more rapidly in the mining industry than in the rest of the
economy since the beginning of the terms of trade boom, with much of this
adjustment occurring between 2004 and 2008 (Figure 11). As a result, the relative
wage in mining increased by about 9 per cent over the eight years to 2012
(Figure 12). This was by far the largest increase of any single industry, after having
28
trended lower over the decade leading up to the boom. 14 It also appears that
relative wages increased in sectors complementary to resource extraction,
principally resource-related construction and mining services. 15
Figure 11: Wage Price Index Growth by Sector
Year-ended
%
%
Mining
6
6
5
5
Non-tradable
4
4
3
3
Other tradable(a)
2
2
1
1
2000
Note:
2003
2006
2009
2012
(a) Excludes agriculture
Sources: ABS; authors’ calculations
14 In this section, mining is defined as resource extraction excluding resource-specific
manufacturing.
15 Wages in construction and professional services increased strongly between the mid 2000s
and 2012, relative to other industries. While ABS data on wages cannot be disaggregated into
resource- and non-resource-related construction and business services, the RBA’s liaison
program suggests that the wage data by industry are likely to mask stronger growth in
resource-related construction and services and weaker outcomes in construction and services
not exposed to the resource sector.
29
Figure 12: Relative Wage Levels
Sector WPI as a ratio to aggregate WPI, 2003/04 average = 1.0
Ratio
Ratio
1.08
1.08
Mining
1.06
1.06
1.04
1.04
1.02
1.02
Non-tradable
1.00
1.00
Other tradable(a)
0.98
0.98
0.96
0.96
2000
Notes:
2003
2006
2009
2012
WPI refers to the wage price index
(a) Excludes agriculture
Sources: ABS; authors’ calculations
There was very little movement in the relative wage in the non-tradable sector
overall and a decline in the ‘other tradable’ sector. This has been a key mechanism
facilitating the reallocation of labour between sectors, whereby sectors benefiting
from output price increases can afford to pay the higher wage rate and so draw
labour away from other sectors.
While these adjustments in relative wages were substantial, the adjustment to the
absolute level of nominal wages overall was smaller than in previous terms of
trade booms, such as the early 1970s energy boom (Figure 13). This outcome in
the current resource boom was helped by the combination of well-anchored
inflation expectations and a more flexible labour market, particularly in
comparison to earlier terms of trade booms. During these earlier booms, inflation
was more variable and Australia’s centralised wage-setting system had the effect of
spreading wage increases across the economy to occupational categories for which
the value of marginal product had not increased. Not surprisingly then, the result
was a rise in inflation and unemployment (Gruen 2006; Battellino 2010;
30
Banks 2011). While the adjustment of relative wages during the current boom has
been substantial, the need for relative wages to adjust may have been lessened by a
number of factors that have increased the supply of labour to the resource sector,
such as: the adjustment in participation rates across different regions; the utilisation
of skilled labour sourced from offshore by the resource sector; interstate migration;
and employment practices such as fly-in fly-out and drive-in drive-out
arrangements (see D’Arcy et al (2012) for details).
Figure 13: Resource Booms and the Macroeconomy
Index
1971/72 = 100
160
2003/04 = 100
Index
160
(a)
Terms of trade
100
100
(a)
%
Nominal TWI exchange rate
Minimum award wages growth
Wage price index growth
Mining
40
%
40
All industries
20
20
0
1973
Note:
1978
1983
2002
2007
0
2012
(a) Log scale
Sources: ABS; RBA
3.2.5 Consumer prices
Consumer price inflation has averaged around 2¾ per cent since the mid 2000s
(Table 1). This is within the inflation target of 2–3 per cent over the cycle, but
marginally higher than the average of 2½ per cent over the preceding decade. Even
so, this can be considered as a relatively good outcome given the magnitude of the
shock to the terms of trade, and also the much higher inflation outcomes associated
with previous resource booms in Australia (Figure 14).
31
Figure 14: Terms of Trade and Consumer Price Inflation
Quarterly
Index
%
175
20
Terms of trade
(LHS, 2003/04 average = 100)
150
15
125
10
100
5
75
0
(a)
CPI
(RHS, year-ended)
50
1952
Notes:
1967
1982
1997
-5
2012
Financial year data prior to 1959
(a) Excluding interest charges prior to September quarter 1998 and adjusted for the tax changes of
1999–2000
Sources: ABS; Gillitzer and Kearns (2005); RBA
While inflation has been well contained, there were large shifts in relative
consumer prices. Non-tradables inflation throughout the period of the terms of
trade boom was stronger relative to its pre-boom average, as higher domestic cost
pressures fed through to prices. Other factors less directly related to the resource
investment boom also contributed to higher non-tradables inflation. For example,
utilities price inflation picked up significantly from 2007, reflecting the move
towards cost-based pricing, the replacement and expansion of infrastructure, and
rising input costs (Plumb and Davis 2010). Productivity growth has also slowed
since the early 2000s, although it is estimated to have picked up more recently.
At the same time, the higher exchange rate contributed to a noticeable decline in
tradables inflation. Hence, the ratio of non-tradable to tradable consumer prices
rose much more rapidly after 2003 compared to the trend of the previous two
32
decades (Figure 15). 16 This earlier underlying trend reflects the Balassa-Samuelson
effect, whereby productivity tends to rise more rapidly in the tradable sector than
the non-tradable sector. So, even though wages will tend to equalise across sectors
over the longer run, unit labour costs rise more rapidly in the non-tradable sector. 17
The fact that the ratio of non-tradable prices to tradable prices has risen faster than
this earlier trend is consistent with the theory outlined in Section 2.
Figure 15: Ratio of Non-tradable to Tradable CPI
March quarter 1982 = 1.0
Ratio
Ratio
1.4
1.4
1.3
1.3
1.2
1.2
1.1
1.1
Fitted trend
1982–2003
1.0
0.9
1982
Notes:
1.0
1987
1992
1997
2002
2007
0.9
2012
Adjusted for the tax changes of 1999–2000; non-tradable CPI is also adjusted for interest charges prior to
September quarter 1998 and deposit & loan facilities to June quarter 2011.
Sources: ABS; RBA
3.2.6 Interest rates
Interest rates rose over the first part of the terms of trade boom, from a bit below to
a bit above their average over the post-1992/93 period. In part, this reflected the
response of monetary policy to inflationary pressures building on the back of the
boom in the terms of trade, as well as the increasing return to capital in Australia at
that time. Thereafter, interest rates declined sharply in response to the global
16 The picture is similar if utility prices are excluded from the calculation.
17 See Balassa (1964) and Samuelson (1964).
33
financial crisis. There has been considerably less adjustment of interest rates in the
current episode, however, relative to earlier terms of trade booms. One reason is
that the flexible exchange rate now provides a considerable buffer against external
shocks, so that less adjustment of interest rates is required to manage domestic
monetary conditions (Debelle and Plumb 2006).
3.3
Phase III: Mining Production and Exports
3.3.1 Mining production and exports
The response of mining production and exports to the increase in commodity
prices followed with some delay, reflecting the time needed to plan, gain approval
for, and reallocate scarce productive inputs to enable construction of new
infrastructure. For some resource commodities, there has already been a significant
pick-up in output and exports. Since the onset of the terms of trade boom, the
volume of iron ore extracted and exported has risen at an annual rate of
11¼ per cent (Figure 16). LNG extraction has also risen strongly. Coal production
has expanded, but at a broadly similar pace to its pre terms of trade boom average,
in part reflecting a sluggish recovery in coal production from the floods in early
2011.
Given the significant expansions in capacity in the resource sector over recent
years, and the lag between investment and the corresponding output, the
production phase of the resource boom is expected to gather momentum over the
next couple of years. In its projections published in March 2013, the Bureau of
Resources and Energy Economics anticipated strong growth in iron ore and coal
exports over the next half decade, of around 9¾ per cent per year (Figure 16).
Growth in exports of LNG is expected to be even stronger, and this could see
Australia emerge as the second largest global supplier of LNG in coming years
(Jacobs 2011). With the terms of trade forecast to decline gradually over time, it is
likely that the growth in the value of resource exports will be less than the growth
in the volumes.
34
Figure 16: Selected Resource Exports
Financial year
Mtpa
Bulk commodities
Liquefied natural gas
800
Mtpa
80
Iron ore
600
60
400
40
Coal
200
20
0
1994
2006
2018 1994
Note:
BREE projections for 2012/13–2017/18 as at March 2013
Source:
Bureau of Resources and Energy Economics (BREE)
2006
0
2018
The strong growth in production and exports of these commodities over recent
years has been offset, to a large extent, by weaker performance in other resource
commodities. Most notably, oil production peaked in 2000, and since then has
fallen by around 45 per cent as a result of the exhaustion of several of Australia’s
major oil basins. Exports of processed metals also remains below its levels in the
early 2000s, and growth in non-ferrous metal ore exports (which include bauxite,
copper ore, gold ore and nickel ore) has been sluggish relative to growth in iron
ore, LNG and coal exports.
Reflecting these offsetting developments, the volume of Australia’s total resource
exports has risen at an annual rate of 3½–4 per cent over the course of the terms of
trade boom (Table 1 and Figure 17). This is a notable slowing from its 1993–2003
average of 5½ per cent, notwithstanding a more than doubling of the capital stock
and employment in the resource extraction sector. However, as noted above, the
volume of Australia’s resource exports is expected to increase at a faster pace in
coming years as a result of the increase in investment.
35
Figure 17: Exports by Sector
Share of total exports, financial year
%
%
(a)
Non-resource
Resource
70
70
Volume
60
(2010/11 prices)
60
50
50
40
40
Value
30
30
20
1982
Note:
1997
2012
1982
1997
20
2012
(a) Excludes RBA gold transactions
Sources: ABS; RBA
3.3.2 Non-resource exports
The high level of the exchange rate and the impact of the global financial crisis on
external demand have weighed on exports of non-resource goods and services.
Exports of manufactured products from Australia remain well below their 2008
peak, even though the volume of global trade has surpassed its 2008 level
(Figure 18). In particular, some of Australia’s more traditional manufacturing
export sectors, such as construction materials and road vehicles, are well down on
their earlier levels. That said, there has been growth in some categories of
manufactured exports, including specialised industrial machinery and professional
and scientific instruments.
36
Figure 18: Non-resource Export Volumes
Log scale, quarterly
$b
Manufacturing
Services
Rural
$b
14
14
12
12
10
10
8
8
6
6
4
2005
Note:
2010/11 prices
Source:
ABS
2012
2005
2012
2005
4
2012
Exports of services have also declined significantly since 2008, although this also
reflects the tightening of conditions for obtaining student visas, and more recently
there has been some recovery in exports of tourism. In contrast to the softness in
manufactured and services exports over recent years, rural exports have grown
strongly, helped by improved rainfall and relatively high prices for many rural
commodities.
The strong growth of economic activity in Asia is clearly evident in the shares of
Australian exports by destination. In 2011/12, Asian economies (excluding Japan)
accounted for half of Australia’s rural exports, compared to around one-third in
2000, and over 30 per cent of manufactured exports (Figure 19). 18 The share of
Australia’s services exports to non-Japan Asia has also increased, underpinned by
strong growth in exports of education services. Also, short-term arrivals from
China have been increasing rapidly – by around 13 per cent per annum over the
18 In this section, Asian economies include China, Hong Kong SAR, India, Indonesia, Korea,
Malaysia, the Philippines, Singapore, Taiwan, Thailand and Vietnam.
37
past five years to be the second most important source of short-term arrivals (after
New Zealand).
Figure 19: Non-resource Exports to Non-Japan Asia
Share of respective category of exports, financial year
%
Manufacturing
Services
Rural
30
%
30
Other
20
20
10
10
China
India
0
2006
2012
2006
2012
Source:
ABS
3.4
Beyond the Resource Investment Boom
2006
0
2012
The phase of strongly rising commodity prices has now passed. The economy is
still in the midst of the boom in resource investment, although prospects are that it
will peak sometime this year. So it is important to consider how the broader
economy might evolve as the resource sector transitions from the investment phase
to the production phase of the boom.
The stylised framework of Section 2 can help us think about the evolution of the
economy as this transition occurs. An efficient, forward-looking foreign exchange
market should already have factored in the expected decline in commodity prices
associated with the gradual increase in global supply. To the extent that commodity
prices and the terms of trade decline by more than anticipated, this would be
expected to lead to a further depreciation of the exchange rate. Even if this were
not the case, with the mining production phase less labour intensive than resource
38
investment, this should free up some labour to move back into the ‘other tradable’
and non-tradable sectors, and wage pressures should moderate. This could lead to a
reduction in domestically sourced cost pressures, although this will be offset to
some extent by greater imported cost pressures arising from any exchange rate
depreciation should that occur. This would also provide stimulus to the ‘other
tradable’ sector by improving its international competitiveness.
In terms of how this translates to recent and expected developments in the
Australian economy, we have already witnessed a decline in the terms of trade,
which has decreased by around 17 per cent from the peak in September 2011.
Current forecasts (as of the February 2013 SMP) suggest that the terms of trade
will remain high in comparison to pre-boom levels. While it is impossible to be
precise about the magnitude or the timing of near-term movements in commodity
prices, this assumption seems reasonable on the grounds that industrialisation and
urbanisation in China still has some way to run. For example, some estimates
suggest that Chinese demand for steel used in residential construction will not peak
until several years from now (Berkelmans and Wang 2012) – and the continued
development of countries such as India, Indonesia and Vietnam will add
significantly to global demand for commodities.
However, while the terms of trade have declined from their peak in late 2011, the
Australian dollar remains at a high level by historical standards. One interpretation
of this is that the decline in the terms of trade from their peak was anticipated and
therefore already ‘priced in’ to the level of the exchange rate. But this ignores the
unanticipated deterioration in the global economic outlook that underpinned the
decline in commodity prices at that time. The high level of the Australian dollar
might also reflect stronger economic growth in Australia relative to many other
advanced economies over recent years, as well as increased demand for Australian
dollar-denominated assets as other central banks attempt to stimulate their
economies via large-scale expansion of their balance sheets (Lowe 2012a;
Debelle 2013). How the economy adjusts in the years ahead will depend, in part,
on how the exchange rate responds to economic developments; in particular, to the
extent that the exchange rate does not depreciate in line with any unexpected
declines in the terms of trade, this will affect the adjustment in other sectors of the
economy, notably the ‘other tradable’ sector.
39
If the resource investment profile described above is realised, then overall demand
for labour in the resource sector is expected to ease at some point. By itself, this
would tend to lead to some moderation in inflationary pressures in the non-tradable
sector. Conversely, any depreciation would exert some inflationary pressure on the
prices of imported goods and services. Looking even further ahead, as Asian
economies continue to develop and incomes rise, history suggests that demand will
broaden beyond resources to other goods and services. Given the population of
developing Asia, the Asian market is large and is expected to get much larger still;
by 2020, more than half of the world’s ‘middle class’ could be in Asia
(Kharas 2010). From Australia’s perspective, this could result in rising Asian
demand for industries such as tourism, education, financial and other professional
services, food and agribusiness, and specialised manufacturing, particularly related
to agriculture and mining. As noted above, there is some evidence that this is
already occurring.
Another important feature of emerging Asian economies that will have
implications for Australia is the continued development and integration of Asian
financial markets. While the economies of Asia are highly integrated into the
global trading system for goods and services, this is less true of financial systems
in general across Asia (Lowe 2009). Even though saving ratios have been higher
than investment ratios in emerging Asia in recent years these ‘excess savings’ have
predominantly been channelled to the rest of the world by the public sector as
authorities, such as central banks and sovereign wealth funds, buy foreign assets.
While investment in Australia from emerging Asian economies has grown in
recent years, it still represents only a small share of total foreign investment in
Australia. For example, Chinese investment in Australia has increased rapidly
since the mid 2000s – driven by strong foreign direct investment, particularly in
the Australian resource sector – but still represented only 1 per cent of total foreign
investment in Australia at the end of 2011 (investment from the United States in
Australia was 27 per cent of the total).
4.
Conclusion
Strong growth in Asia is expected to continue to provide significant benefits for the
Australian economy. Most notable so far has been the resource boom. The first
phase of this saw commodity prices and hence Australia’s terms of trade rise
40
significantly over a period of a number of years. This phase appears to have
passed, with the terms of trade having peaked in late 2011, although they remain at
a high level. The second phase, the surge in investment in the resource sector, has
been in progress for some years and still has some way to run, with resource
investment expected to peak as a share of GDP sometime over the course of this
year, but remain quite high for a time. The third phase of increased production and
exports of resources has also commenced but has much further to run, especially in
the case of LNG, for which investment takes place over a number of years before
production comes on stream.
The pattern of structural adjustment to the rise in the terms of trade has, to date,
proceeded broadly in line with that suggested by a simple theoretical model. In
particular, relative wages and prices have adjusted in a way that has facilitated the
reallocation of labour and capital towards the resource sector. While not all parts of
the economy have benefited from the boom, the process of macroeconomic
adjustment has occurred relatively smoothly compared to previous booms;
inflation has been consistent with the target, unemployment has remained
relatively low and output has grown at close to trend rates. This stands in stark
contrast to some earlier episodes of terms of trade booms in Australia. One critical
element to the adjustment this time around has been the timely appreciation of the
nominal exchange rate as the terms of trade were rising. The adjustment has also
been helped by the anchoring of inflation expectations and the operation of the
labour market, whereby wage pressures in industries or regions experiencing
strong conditions associated with the resource boom have not spilled over to parts
of the economy experiencing weaker conditions.
A significant proportion of the employment growth in the resource sector over
recent years has been driven by the relatively more labour-intensive activities
associated with resource investment. Once resource investment peaks, demand for
labour in the resource sector is expected to decline and the contribution of resource
investment to output growth will turn around. Part of this will be replaced by
increased production and export of resources. The extent to which a pick-up in
other activity requires a shift in relative prices, including through the exchange
rate, remains to be seen.
41
Looking further ahead, there will come a time when the demand for commodities
will ease as the development of economies in the Asian region continues and the
focus of consumption shifts away from goods and towards services. Such a
transformation might appear to be disadvantageous for economies such as
Australia that have hitherto been focused on supplying these economies with
commodities. However, rising demand for household, business and financial
services in Asia has the potential to be relatively advantageous for the Australian
economy, in part because it is closer to this region than it is to most advanced
economies, but also because of its well-developed and relatively open services
sector.
42
Appendix A: Data
Table A1 presents the import penetration and export propensity for the 19 ABS
industry divisions, based on ABS input-output tables for 2008/09.
Table A1: Sector Definitions and Trade Exposure
2008/09, per cent
Mining
Other tradable
Agriculture, forestry & fishing
Manufacturing
Wholesale trade
Accommodation & food services(c)
Transport, postal & warehousing
Non-tradable
Electricity, gas, water & waste services
Construction
Retail trade
Information, media & telecommunications
Financial & insurance services
Rental, hiring & real estate services
Professional, scientific & technical services
Administrative & support services
Public administration & safety
Education & training
Health care & social assistance
Arts & recreation services
Other services
Notes:
Import
penetration(a)
Export
propensity(b)
13
22
2
33½
0
8¾
8½
1½
0
0
0
7¾
1
1¾
3¾
1¾
0
2¾
½
3
¾
60¾
18¼
15½
22
10¼
11½
19½
1½
0
¼
3
2½
1
¾
3¾
1¾
¼
7¾
½
4
½
(a) Import penetration equals competing imports as a share of the total supply of the corresponding
domestic industry
(b) Export propensity equals exports as a share of total production in each industry
(c) Due to data limitations, the accommodation & food services industry is included in the non-tradable
sector in Figures 6–9
Sources: ABS; authors’ calculations
43
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